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Mergers Boost Nasdaq Inc. Revenue While Pressuring Profits

The exchange operator and financial-industry services provider benefited from recent acquisitions in the second quarter of 2016, as revenue rose 8%. But the short-term cost of deal making also dragged on profits.

Nasdaq Inc. (NASDAQ:NDAQ)is beginning to reap the rewards of recent merger activity, as second-quarter 2016 results, released on July 27, made clear. But at least in the short term, the company is also tallying up significant acquisition costs. Below, I'll take a global view of the quarter, check in on the company's operating segments, and discuss merger-related adjustments to earnings.

Nasdaq Inc.: The raw numbers

Metric

Q2 2016 Actual

Q2 2015 Actual

Growth (YOY)

Revenue

$559 million

$518 million

7.9%

Net income attributable to Nasdaq Inc.

$70 million

$133 million

(47.4%)

Diluted earnings per share

$0.42

$0.77

(45.4%)

Data source: Nasdaq Inc. 8-K filing, July 27, 2016.

What happened with Nasdaq Inc. this quarter?

The company's 8% revenue growth was made possible by recent acquisitions. Of the $41 million improvement from Q2 2015, $24 million derived from acquired revenue, $14 million represented organic growth during the quarter, and foreign-currency translation provided a $3 million boost.

Nasdaq's largest operating segment, market services, which comprised 35% of the company's total top line during the quarter, grew revenue by 2.6%, to $194 million, and operating income by 5%, to $105 million, on the strength of equity derivatives and cash equities trading revenues.

At 29% of total company revenue, the technology solutions segment continues to inch up in importance each quarter. Revenue expanded 20.7%, to $163 million, and operating income leaped 52.6%, to $29 million. Most of this progress was due to the inclusion of two recent acquisitions, Marketwired and Boardvantage, in the segment's profit and loss statement.

The information-services division was responsible for 24% of Nasdaq's revenue in Q2. A modest revenue improvement of 4.6%, to $134 million, was matched by an increase of 7.9% in operating income. Revenue from data products offset a decline in fees from index licensing and related services.

Listing services, Nasdaq's smallest segment, increased its top line by 3%, to $68 million, but produced flat operating income of $29 million versus the comparable prior-year quarter.

Nasdaq Inc. continued to achieve momentum in public listings. The company completed 106 new listings in the second quarter. In the U.S. market, Nasdaq boasted 73 new listings, which included 25 IPOs, or 69% of all U.S. public offerings during Q2 2016.

In addition to the two acquisitions mentioned above, Nasdaq also completed the purchase of options exchange operator ISE on June 30, 2016 -- the last day of the quarter.

As you can see from the table at the beginning of this article, though revenue climbed, profits were almost 50% off the mark set in Q2 2015. Two large adjustments on the income statement explain the drop. First, under the line item "Merger and Strategic Initiatives," the company incurred $35 million of charges in Q2 2016, versus $3 million in Q2 2015. These charges stem from merger activity, including due diligence, legal fees, integration costs, etc., indicating that, at least for the time being, costs outweigh synergies derived from Nasdaq's recent string of small, bolt-on acquisitions.

Second, Nasdaq incurred $33 million in restructuring charges during the period, versus $2 million last year. The restructuring charges originate from a strategic review initiated at the outset of 2015. Nasdaq attributed the current-period charges primarily to severance costs and asset impairment writedowns.

What management had to say

In the company's second-quarter report, management perhaps anticipated shareholder concerns over the effect of both acquisitions and restructuring on near-term profits. CEO Bob Greifeld observed the following in Nasdaq's earnings filing:

In addition, we expect our recently announced acquisitions, which are strategically aligned with our vision and business direction, to significantly enhance the effectiveness of our value proposition to serve our corporate and capital markets clients, while creating significant value for our shareholders.

Moving forward

Backing out the $63 million in additional acquisition costs and restructuring charges versus the same period last year, the company would have achieved a net profit margin of nearly 24% in the second quarter. In comparison, during Q2 2015, Nasdaq's net profit margin hit 25.6%. Thus, over a longer time frame, shareholders will likely appreciate the addition of several percentage points of revenue via acquisition, at a profitability level that should approach or perhaps exceed former thresholds. And of course, investors shouldn't be surprised to see further deal-making activity from Nasdaq in the near future.